Businesses run on capital, and your company's working capital is the amount you have available to keep your operations going. Although the amount of working capital that you have available isn't necessarily a precise measure of your company's financial health, this number does provide information about your current cash flow position and the ease with which you can make critical short-term investments.
The Working Capital Formula
Calculate your working capital by subtracting current assets from current liabilities. Assets include cash in the bank and cash-on-hand, accounts receivable which will be collected in the near future and inventory that you can use to produce the products and services you sell. Liabilities include unpaid bills, short-term borrowings that need to repaid soon and longer-term liabilities such as loans that affect your current cash flow because you're making ongoing payments. Subtracting the sums you need to pay soon from the amounts you'll have available to pay them tells you how much you have left over to cover day-to-day business activities.
Why You Need to Know Your Working Capital
It costs money to run out of money. Capital shortfalls lead to overdraft fees and the disadvantageous interest rates that you'll likely pay if you have to borrow on credit cards or find other sources of quick and convenient cash. If you know day-by-day how much working capital you have available, you can plan inventory purchases and other longer-term investments to coincide with the availability of the cash. Knowing how much working capital you have, also helps you to take care of your employees and suppliers. Payroll tends to be the most urgent expense that a business has to cover because your company can't run without its employees, and they depend on the regular paychecks you issue for survival. Supplies and inventory can be equally important: you can't make sales and bring in new working capital if you have nothing to sell. You owe it to your employees and suppliers to manage your working capital well enough to pay them what they're due and make these payments on time.
Managing Working Capital
If you manage your working capital with savvy and skill, you'll likely have more working capital available. Prioritize your bills and expenditures so you pay the most urgent items first, and only pay what's necessary when cash flow is tight. Time your outgoing expenditures to coincide with incoming capital. You may have to sometimes pay more in the short-term if you buy items in smaller quantities and forgo the savings of purchasing in bulk. But spending money strategically will likely earn your business more in the long-term if you keep enough cash on hand to avoid interruptions and missed opportunities.